One in four savers has 401(k) ‘leakage’

By Anne Tergesen

One in four 401(k) participants has, at some point, raided his or her 401(k) savings to cover non-retirement expenses, including mortgages, college tuition, and credit card bills, according to a study released this week.

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Workers withdrew $70 billion from their 401(k) plans for non-retirement needs in 2010, says the report by HelloWallet, a company that sells personal-finance and budgeting technology to employers. The “leakage” represents a significant share of 401(k) assets: By comparison, the report says, employees contributed about $175 billion to their 401(k) accounts in 2010, while employers contributed about $120 billion in matching contributions.

Retirement account leakage occurs in three forms: loans, hardship withdrawals, and cash-outs, which occur when employees withdraw all their money upon leaving a company.

Some leakage is worse than others. Brigitte Madrian, a professor at Harvard University’s Kennedy School of Government, says that while loans, including those taken out for home down-payments, are the “biggest way that people tap into their accounts, most of that money is repaid.” (Typically, only about 15% of 401(k) loans default, Madrian says, and participants who take loans don’t typically reduce their contribution rates while the loans are outstanding.)

The bigger problem, Madrian adds, concerns cash-outs. While those who cash-out their accounts tend to have small balances, “as a whole, it adds up to a lot of money.” When accountholders cash out before the age of 59 ½ without rolling the money into another qualified retirement plan, they owe income tax on their cash-out, plus a 10% penalty. Most of the cash-outs in the study fall into this category. If cash-outs, loan defaults, and hardship withdrawals could be stopped, “it wouldn’t be unreasonable to get a 30% increase in cumulative accumulations” in retirement accounts, Madrian says.

The HelloWallet report is available here for readers willing to provide their email address to the company. Among its other findings are:

- Tax-penalized withdrawals taken by participants 59 ½ or younger increased from $30 billion in 2004 to almost $60 billion in 2010.

- Workers in their 40s are most likely to breach their savings for non-retirement needs.

- Over 70% of those who raid their accounts report that they did so because of basic money management problems.

HelloWallet sells a mobile app and online program to employers, who in turn offer them to employees to help them keep track of their finances. (For more on such apps and tools, see the Wall Street Journal’s “Seven Resolutions to Get Your Nest Egg in Shape.”)

The report concludes that many of the employees who have taken loans, cash-outs, and hardship withdrawals would be better off if their employers were to encourage them to build emergency savings before funding a 401(k) plan. These participants “are unnecessarily paying investment management and advice fees, mutual fund, administrative, and trading fees and are likely over-investing in risky equity and bond investments that are not appropriate for short-term savings needs,” the report says.

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Encore looks at the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities, needs and priorities of people saving for and living in retirement. Our lead blogger is editor Matthew Heimer, and frequent contributors include editor Amy Hoak, writer Catey Hill, and MarketWatch columnists Elizabeth O’Brien, Robert Powell and Andrea Coombes. Encore also features regular commentary from The Wall Street Journal retirement columnists Glenn Ruffenach and Anne Tergesen and the Director of the Center for Retirement Research at Boston College, Alicia H. Munnell.